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Friday, March 8, 2013

Swiss Say on Pay: The Dangers

In Wednesday's post, (Mad as Hell and Not Going to Take This Anymore) Joe discussed shareholder frustration inherent in Switzerland's recent decision to give shareholders a binding say on pay. He anticipated that I might take a different view and he was correct. I promised a response. As I reread the post, however, I found sympathy with some of the concepts. It is tough to justify some of the pay packages that we see awarded. And, Joe notes that the Binding Say on Pay may not be the right vehicle to vent frustration. I agree, and I'm generally less excited about this new law. Here are some thoughts.First, concern about executive compensation is not new. A quick search of the New York Times headlines finds complaints similar to today even back in the 1920's. Now this could mean that a) executive comp attracts attention, b) big salaries attract attention or that c) executive compensation - was and continues to be - a problem. Probably all three are correct. However, while the first two items are probably true without qualification, the same cannot be said for item (c). Not all executive compensation is a problem.So my second point is that we must be careful with new regulation. Boards exist to find the best solutions for their shareholders. Yes, there are excesses and they attract our attention and yes, boards must be held accountable. But compensation is a board responsibility. Boards are capable and should hire whatever expertise they require to get compensation right. The board is the expert on this or can hire the expert. The same cannot be said for the mass public, particularly if they are inflamed by headlines or influenced by single item advocates. Binding Say on Pay on all companies is dangerous. I'll discuss our own research on Say on Pay in the US next week. It shows that one size doesn't fit all with regard to US legislation. The same can be said of any other type of corporate governance. Boards need the flexibility to handle the individualized needs of their companies.Third, as I've written elsewhere, the regulatory pendulum swings from too little to too much, but tends to get stuck on one side - the side of too much regulation. It is easier to see egregious problems and create new regulation. But it is more difficult to dismantle that legislation when it is excessive. Regulatory agencies like all life forms, develop defense mechanisms.Fourth, a ban on all golden parachutes is dangerous. I too, have great skepticism on some golden parachutes. And our own research shows that when the parachutes are out of line with other elements of a merger pay package, bad results follow. (See Golden Parachutes and the Art of the Deal.) But parachutes can serve useful functions as well. In particular, they help align incentives and protect CEOs from a new owner reneging on implicit contracts about pay for performance. When designing a pay package boards can't anticipate every contingency. Hence, implicit contracts arise, such as a board telling a CEO 'trust us, if you enhance value, we'll do right by you.' Such a contract is meaningless with a change in control. Golden parachutes can ease that problem. They also mitigate the moral hazard problem that arises when the best thing a CEO can do for shareholders is step aside and recommend going along with a takeover. Admittedly, boards should be monitoring self-serving behavior on the part of the CEO but a well designed parachute can align incentives. Our own research shows that a poorly aligned parachute can create a rush to sale or unyielding resistance to a deal. Neither will benefit shareholders. But the solution is not to ban all parachutes, but to get the GP right.Fifth, where does this type of legislation stop? Some have already argued for binding votes on the ratio of CEO pay to that of the average worker. Such rules are foolish attempts to legislate the laws of economics. However, (and fortunately) the laws of economics answer to a higher authority: supply and demand. As a colleague once told his University Dean, "You don't determine my salary - you only influence where it get's paid." So watch what happens when salaries are rigidly capped regardless of market value. The most highly valued leave, reducing the quality of the organization. Alternatively, (and as press reports already note) some companies are talking of moving their headquarters from Switzerland.In the US, of course, where Say on Pay votes are not binding, almost all Say on Pay votes are highly supportive of executive pay, so all of this may be of little concern. To my way of thinking, however, it is a dangerous development.

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About MergerProf

In addition to their day jobs, Joe and Ralph teach acquisition finance at the Amsterdam Institute of Finance. This blog was created in the summer of 2012 as a tool for those interested in acquisition finance and related material. Admittedly, we define related material broadly to include mergers, private equity, banking, governance, deal making and, well, finance in general. We hope you will enjoy and contribute, critiquing, expanding and providing your own examples related to the posts. We encourage you to join us in this adventure and, for some of you, to see you in Amsterdam, New York or Philadelphia.